Income trusts from across Canada are facing an uncertain future following the recent crackdown by Ottawa – prompting entertainment-related outlets such as Rainmaker, Cineplex and Cinram to rethink their tax planning and corporate structure, while giants including BCE and Telus backpedal from plans to convert to the formerly popular tax dodges.

Existing income trusts saw their market valuations plunge by up to 20% after the federal government announced on Oct. 31 that it will tax payments to income trust unit holders after 2011.

That four-year grace period gives the trusts time to develop new tax shields before they are taxed like regular corporations. Income trusts avoid corporate taxes by distributing most of their cash flow to individual investors, who are in turn taxed on the payouts they collect.

At the Cineplex Galaxy Income Fund, president and CEO Ellis Jacob says he’s mulling new tax shields, including using his company’s capital cost allowance and depreciation from new-theater construction, or the deduction it takes on the value of its assets, to soften the blow from recent taxation changes.

‘There’s a lot of [tax pool] opportunity and items that need resolution during that four-year period,’ says Jacob.

For example, Cineplex Galaxy generates around $70 million annually in depreciation charges, which could be claimed as depreciation expenses.

Ben Mogil, an analyst with Westwind Partners, anticipates Cineplex will let its depreciation allowances build through 2011 so it can avoid taxes for another two years beyond the four-year grace period.

Warren Franklin, CEO of Rainmaker Income Fund, says it’s business as usual – for now.

‘Since we will continue to distribute through 2011, there will not be a change over the near term, at least until the rules get sorted out and we know how they are treating income trusts,’ he says.

Others see the pall now cast over income trusts as reason to consider taking their companies private, or to make other arrangements.

Cinram International Income Fund, owner of the Toronto-based CD and DVD manufacturing giant, has hired a financial advisor to consider ‘strategic and financial alternatives’ in light of the changes.

‘We do believe these proposed changes will have a significant effect on the market for income trusts in Canada, which could negatively impact on income trust valuations,’ says CFO Lewis Ritchie, though he did not offer specifics.

The tax changes have removed a key investment vehicle for small to medium-sized entertainment companies, according to Carl Bayard, an analyst with Desjardins Securities.

‘They don’t have the profile to go public, but they could become an income fund and distribute all their cash flow to shareholders,’ under the old laws, he says. ‘Now that option is ruled out, and they must remain private for the most part.’

He predicts few income trusts will quickly convert back to a taxable corporate structure.

‘You may as well benefit from the grace period and look at alternative types of tax shelters,’ Bayard advises.

BCE and Telus were preparing to convert to income trusts, but saw those plans die on the vine following the news from Ottawa, which plans to immediately tax income trusts launched after Jan. 1, 2007.

Spokespeople for broadcasters Astral Media and Corus Entertainment confirmed they had no plans to convert to income trusts after earlier considering the possibility.

The crackdown also has implications for companies raising financing for new acquisitions, especially after the Ministry of Finance ruled that income trusts can sell or issue equity up to a maximum 15% of their market value, limiting their ability to raise new equity.

Companies like Cineplex, which integrated Famous Players, and Rainmaker, which ingested Mainframe, insist they’ve made their biggest acquisitions already. But other income trusts are asking themselves where growth capital can be secured given taxes and a new regime unfolding for their once tax-advantaged investment vehicles.

There’s an immediate impact on the Movie Distribution Income Fund, which is now up for sale along with Alliance Atlantis Communications’ own interest in Motion Picture Distribution LP. A lower unit price for the trust means a lower price for a potential buyer.

An AAC spokesperson says it’s too early to speculate on possible tax shielding scenarios until the new rules become clearer.

At the same time, the question may be moot, as the common belief is that MDIF will go private after a possible sale.